Assessing China’s Plans to Open its Car Market

In the midst of escalating trade tensions between the U.S. and China, Xi Jinping announced that China would liberalize its car market by 2022. Foreign investment into the Chinese car market is subject to a joint-venture requirement with 50% Chinese ownership. Car imports are subject to a 25% tariffs.

In 2017, China saw $24 million in car sales, making it the world’s largest car market, ahead of the US and the EU. China is already the world’s largest market for new energy vehicles, with sales of $777,000 in 2017. Much of this is due to the enormous subsidization of electric vehicles for environmental and industrial policy purposes.[1]

The Environment for Foreign Automakers in China

Prior to forming the joint venture, the foreign automotive investor must agree to share technology and proprietary production methods with local partners. It must also agree to employ Chinese upper management. Elon Musk has publicly criticized China’s trade policy, citing both the massive import tariff and joint venture requirement. The joint-venture requirement hits innovation and technology-based car companies like Tesla particularly hard.

Foreign car companies must also tolerate a growing government presence deep within their companies, as the Chinese Communist Party has doubled down on its pledge to increase government oversight throughout all corners of society. 70% of foreign-funded firms have a Communist Party branch overseeing their company.[2] This raises the concern that industrial policies makers can study how to best rig the rules in the favor of domestic companies. However, one can only speculate, as the intentions and activities of these party branches are non-transparent.

Due to high tariffs, the U.S. exports approximately 250,000 cars to China annually.[3] Accordingly, most major car companies have shown willingness very early on to tolerate the joint venture requirement as the admission price to the massive Chinese market. These close and long-running partnerships generate enormous sales for foreign car companies. Foreign car brands maintain a dominant position in the Chinese car market, though these days are numbered, as domestic brands are catching up quickly. 6 of the 10 best selling car brands in China in 2017 were foreign.

Liberalization Plans

China will permit foreign automakers to fully own factories in China, eliminating the 50% Chinese ownership requirement. Electric vehicle producers will be able to open wholly foreign owned factories in 2018. The joint venture requirement for the production of commercial vehicles will end in 2020, while the requirement for passenger vehicles will fully end in 2022. Xi Jinping has also said that China would reduce the current 25% import tariff on cars.

Remaining Issues and Uncertainties

The announcement of the liberalization of the auto market leaves a number of problems and uncertainties for foreign automotive companies. For one, the announcement has not addressed the current requirement that electric car batteries be made in China. Additionally, local subsidies for electric cars are only available for cars with Chinese-made batteries. When these subsidies eliminate almost half of the final price of the vehicle, they constitute a monumental trade barrier. For instance, Hyundai’s New Uiedung EV, which uses Chinese-made batteries, receives 89,000 RMB in subsidies, accounting for 44% of the price.[4]

As part of the Made in China 2025 plan, China hopes to build national champions in futuristic automotive technologies, such as electric cars and autonomous vehicles that can conquer global markets.[5] Thus, even if foreign investors enjoy these liberalization measures, it is likely that a complex of non-trade barriers will remain. For instance, the government will continue to subsidize these companies in a variety of ways and they will continue to enjoy close relationships with authorities (a privilege not extended to foreign companies).

Despite the obvious disadvantages to joint-venture requirements which implicates intellectual property, they do have advantages for foreign companies. Since the announcement to liberalize the auto market, a number of companies including BMW, Volkswagen, Daimler, GM, and Honda have suggested that they will remain with their Chinese counterparts for the time being. These domestic partners help foreign investors navigate the Chinese market by sharing their connections to government and bureaucracy – something a wholly foreign-owned company would be unlikely to have. Many foreign businesses suspect that the rules are stacked against them in favor of domestic companies. From this, they may reason that it is safer to remain in a joint venture.[6] Additionally, if these companies decide to do it alone in the Chinese market, they will have to buy out their joint venture partners, which will be extremely expensive.

Of course, the plan to fully open up the car market by 2022 gives Chinese automotive firms 4 years to prepare themselves to whether free market forces. By that time, they may be more competitive and foreign automakers will have less of a foothold in China. Moreover, the willingness to liberalize reflects the government’s confidence in Chinese car companies. The government may also be confident in other policy tools to boost domestic companies (for example, sophisticated methods to nudge Chinese consumers into buying Chinese cars).

Conclusion

The announcement to liberalize the car market was symbolic and significant in a number of ways. The joint-venture requirement is a symbolic aspect of China’s reputation for extracting foreign intellectual property to boost domestic companies. Foreign companies feel that the requirement is a major disadvantage of doing business in China, especially when R&D is a significant part of the company’s expenditure. Removing this requirement in the automotive sector signals the willingness of the Xi administration to move forward with pro-market reforms. It also demonstrates confidence in the strength of the Chinese auto market.

[1] See https://www.ft.com/content/18afe28e-a1d2-11e7-8d56-98a09be71849